Monday, August 17, 2009

Sometimes the IRS runs into a judge who it seems must've had a bad experience with one of its auditors.

A case like that came down last week -- and very unpleasantly for the IRS it came from the second-highest court in the land to open the possibility of $4 billion more in tax refunds coming to all us telephone users.

An open-hand smacking like this is rarely administered by a court to anybody -- and to the federal government itself, less often than that. So I've quoted some paragraphs from it below to enjoy.

The backstory: In 1898, Congress imposed what it described as a temporary "luxury tax" on long-distance phone service to finance the Spanish American war. The tax far outlived its stated purpose (are you surprised?) and was still being collected in 2004 (into it's third century).

But by then phone technology and telephoning practices had changed so much that people started to notice what was taxable by the terms of the tax code no longer corresponded to reality (here's a fuller explanation), and taxpayers large and small began demanding refunds. The IRS lost 10 court cases in a row and then conceded.

At that point the Treasury said that as of the start of 2007 it would refund telephone taxes paid during the prior 41 months (the legal statute of limitations). The IRS issued a formal statement, Notice 2006-50, detailing how refunds were to be claimed. Under it the IRS automatically gave sliding scale refunds by size of household, up to $60 for family of four. Anyone who wanted more than that had to file serious paperwork and produce up to 41 months of phone bills.

One Mr. Neiland Cohen -- a retired former IRS revenue agent for 35 years -- filed for a refund of $50. The IRS said that was more than he was entitled to under its formula and rejected the claim.

Mr. Cohen then sued the IRS for himself and on behalf of other taxpayers. He argued that it had had no right to collect the tax in the first place, and then in its Notice 2006-50 had set the refund formula too low and made the requirements for claiming any further refund impossibly burdensome, to make further refunds impossible and to keep the illegally collected tax money for itself.

He cited the rather persuasive point that of the $8 billion the IRS admitted it had no right to collect, it had refunded only less than half, about $3.8 billion, and kept the rest -- more than $4 billion.

The IRS responded that there was nothing really to sue about, as Notice 2006-50 wasn't any kind of formal, binding statement after all, but just a general advisory, and Mr. Cohen and all other taxpayers were thus perfectly free to request larger refunds under "normal" refund rules.

Mr. Cohen lost his case at the trial court level, then appealed. Last week, the Court of Appeals opined thusly...

In this case it took the Internal Revenue Service’s aggressive interpretation of the tax code to part millions of Americans with billions of dollars in excise tax collections.

Even this remarkable feat did not end the IRS’s creativity. When it finally conceded defeat on the legal front, the IRS got really inventive and developed a refund scheme under which half the funds remained unclaimed.

Now the IRS seeks to avoid judicial review by insisting the notice it issued, acknowledging its error, and announcing the refund process, is not a binding rule [subject to court review] but only a general policy statement....

The IRS insists taxpayers do not need to follow the Notice in order to exercise their right to file a refund suit under § 7422. It claims, "Nothing in [the notice] prohibits taxpayers from submitting otherwise valid claims for refund under the usual statutory procedures..."

That’s just mean. To go the “statutory” route, as the IRS suggests, places taxpayers in a virtual house of mirrors.

Section 7422 ... dictates the appropriate form for the taxpayer to use. It states, in relevant part, that "all claims by taxpayers for the refunding of taxes, interest, penalties, and additions to tax shall be made on Form 843."

Form 843, however, does not permit this type of refund claim. At the top of the form, it reads, "Do not use Form 843 if your claim is for ... overpayment of excise taxes ..." Therefore, taxpayers cannot use Form 843 to file their refund claim.

The instructions for Form 843, however, suggest that taxpayers fill out Form 8849 "to claim a refund of excise taxes ..." and refers them to IRS Publication 510, Excise Taxes, "for the appropriate forms to use to claim excise tax refunds."

But IRS Publication 510 states, "Do not use Form 8849 ... to make claims for nontaxable service; the IRS will not process these claims." Even if the taxpayer ignored the reference to the IRS publication, Form 8849 itself cautions "Do not use Form 8849..."

Counsel for the IRS took the enigmatic position at oral argument that if the taxpayers had used either Form 843 or Form 8849 to file their refund claims, then IRS’s acceptance would have been mandatory ...

But these assertions directly conflict with the cautionary instructions printed in bold typeface on the front of both forms and the explicit directions given in IRS Publication 510. Furthermore, the IRS provided absolutely no authority supporting its position.

In reality, unless taxpayers follow the dictates of Notice 2006-50, they run into nothing but dead ends...

Despite the obvious infirmities of these options, the IRS still has the chutzpah to chide taxpayers for failing to intuit that neither the agency’s express instructions nor the warning on its forms should be taken seriously.

According to the IRS, taxpayers should have realized all the options the Service said were closed to them — using forms that proclaim their inapplicability in bold letter or filing informal claims that could not be perfected — were nonetheless sufficient...

Not hardly. Taxpayers bear a heavy burden when pursuing refund claims, but we have yet to demand clairvoyance...

In sum, the IRS unlawfully expropriated billions of dollars from taxpayers, conceded the illegitimacy of its actions, and developed a mandatory process as the sole avenue by which the agency would consider refunding its ill-gotten gains.

It cannot avoid judicial review of that process by simply designating it a policy statement. Notice 2006-50 constituted a final agency action that aggrieved taxpayers by hindering their access to court.